Reference point adaptation: Tests in the domain of security trading

According to prospect theory [Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk, Econometrica, 47, 263–292], gains and losses are measured from a reference point. We attempted to ascertain to what extent the reference point shifts following gains or losses. In questionnaire studies, we asked subjects what stock price today will generate the same utility as a previous change in a stock price. From participants’ responses, we calculated the magnitude of reference point adaptation, which was significantly greater following a gain than following a loss of equivalent size. We also found the asymmetric adaptation of gains and losses persisted when a stock was included within a portfolio rather than being considered individually. In studies using financial incentives within the BDM procedure [Becker, G. M., DeGroot, M. H., & Marschak, J. (1964). Measuring utility by a single-response sequential method. Behavioral Science, 9(3), 226–232], we again noted faster adaptation of the reference point to gains than losses. We related our findings to several aspects of asset pricing and investor behavior.